Statements brimming with change Accounting

The major accounting firms have just concluded their annual pilgrimages around the country to tell clients to consider finalising financial statements as the annual general meeting season draws nigh. 

It’s also the time of year when many of the changes which some companies have spent little time learning about begin to bite. Shareholders will see differences in the way companies report results and companies will be getting used to new formats of presenting information. Some changes will be merely cosmetic and others are viewed as being a tad more sensitive. All of the changes, however, were introduced because the standard-setters believed they would help companies tell the story of corporate activity with a greater level of transparency. Among the changes that users of financial statements will notice first is the change in the names to a few old friends. Use of the terms "balance sheet" and "statement of profit and loss" will be not in accordance with accounting standards as they are now. Your "balance sheet" is transformed into the "statement of financial position" by the new accounting standard and the place shareholders will look for your profit figure has been christened the "statement of financial performance".

In a sense the change to "statement of financial performance" is convenient because some companies think they are giving investors multiple statements of profit and loss. A cursory glance at the accounts of two of Australia's largest retailers, Coles Myer and David Jones, reveals they believe in giving investors several "statements of profit and loss" rather than a single "statement of profit and loss". Interestingly, the Corporations Law refers to a statement of profit and loss in the singular. Some accounting experts and corporate finance types have complained the accounting standards terminology is not reflected in Section 295 the Corporations Law and the inconsistency is confusing constituents, but there is no statement that demands the profit and loss statement be known by that name. In other words, the provision of the information expected in those statements - irrespective of what they are called - means compliance with the Corporations Law.

One change that has sent a few analysts haywire is the forced exile of the abnormal item from the face of the statement formerly known as the statement of profit and loss. The abnormal item is viewed as having been a reporting device abused by companies over the years for the purposes of window dressing the financial statements. Accounting firms are now suggesting clients avoid the use of the term abnormal and try something else. One reason for this is that the Australian Accounting Standards Board has indicated the use of the term "abnormal" will probably result in the board revising the standard, known as AASB 1018, to ban the term. What options are there? At least one company has an "unusual item" and some companies are preparing to disclose "significant items". Consulting a thesaurus could lead you to some quite interesting terms that would take the place of "abnormal". One edition of a Roget's College Thesaurus offers several alternatives for the CFO seeking a little market differentiation in this respect. Eccentric, monstrous, insane and anomalous items might take the place of abnormal ones. The Macquarie Thesaurus, which makes you look up the wretched thing the hard way by searching through an index, tells you to go look up the entries under "strange". An executive might find comfort in having an iffy, odd, unconformable, esoteric, uncommon or peculiar item in their financial statements.

Extraordinary items have been defined out of existence and only some kind of natural catastrophe such as an earthquake or volcanic eruption is likely to result in an extraordinary item being reported. One practical example of how this will impact some companies is that revenue from the sale of a building - something that might be considered extraordinary for a business that is not a property developer - will be reported as a normal business event. A change that will hit some companies harder than others is the introduction of the requirement to disclose the cost of sales. The concept is really quite simple. In order to sell something you must have stock or inventory or some kind. What you paid to either purchase and deliver the inventory to your premises for sale or you paid to manufacture goods for sale represents the cost of inventory and, consequently, cost of sales. Some people will have no problem with this. Some pockets in the business community will have a degree of difficulty. Retailers have already begun grumbling about the need to show a number for cost of sales on the face of the statement of financial performance.

Competitive pressures have been used as the argument to justify non-disclosure. These numbers are really sensitive, the retailers argue, and competitors could determine profit margins from the annual financial statements. How do you deal with this "sensitivity"? One option raised with, but rejected by, the Australian Accounting Standards Board was the option of delaying the implementation of the accounting standard by a year. Not an option. You see, the standard has been around since October 1999 and now we're in June 2001. One of the problems with the way accounting standards are regarded by the corporate sector is they are generally left on the backburner until a company believes it is appropriate or necessary to deal with them. Timing is always an issue when dealing with institutionalised procrastination within the corporate sector. It is never too early to say there is too little time to learn about and implement a new accounting rule. The other problem some of these critters have with the cost of sales disclosure is they want to use the cost of sales number, which should be strictly determined in accordance with the inventory accounting standard, as a dumping ground for other stuff.

One suggestion is retailers should be given the opportunity to lump in occupancy or rental expenses into the cost of sales category on the statement of financial performance. A sane observer would not take this suggestion seriously. Imagine a scenario where a retailer sells nothing during a given reporting period but has rental expenses of $1000. The advocates of the approach that says dumping rental expense into cost of sales would live with the notion that your cost of sales would equal $1000. In this circumstance cost of sales equals rental expense, which is a nonsense result and points out the relative insanity of seriously contemplating the rental expense being considered as a cost of sales. If those supporting the use of the cost of sales as a dumpster for rental expenses begin suggesting the above scenario is unlike anything they have contemplated then they are being intellectually dishonest with the readers of their financial statements. The situation contemplated is deliberately extreme because the illogicality of the claim being put forward by the retailers needs to be seen for what it is: nonsense.

Another change that will encourage careful thought is the way companies are permitted to revalue assets. Some companies have already changed the way they value their non-current assets after working their way through three choices that are in the accounting standard. A company can elect to jump on a revaluation treadmill that demands the company revisit the values of classes of non-current assets on a regular basis. That option produces information that might be more relevant to users, but it could result in the uplift of asset values that some companies may consider causes them difficulties in terms of depreciation charges. Another option that is offered by the standard is the reversion to one of two types of cost: original cost or deemed cost. If the company is capable of working the numbers back to work out what the historic cost of a class of assets was back when things were purchased it can use those numbers. Winding back time and ending up with a lower value on the statement of financial position means the company will have lower depreciation charges.

Using deemed cost gives a company the opportunity to freeze the value of a class of non-current assets and use it as the cost base for accounting going forward. The choices made in this regard will have an impact on the way financial statements appear to shareholders. At the time of writing a proposal to change the revaluations standard was on the table for the Australian Accounting Standards Board to consider. The AASB had stumbled over a problem put to it by constituents that the standard required companies to stick with the non-current asset measurement bases even when acquired by a company using a different measurement basis for the same class of assets. The proposed amendments would permit companies to change the measurement basis of non-current assets at any time if the result ends up being more relevant and reliable. That may be welcomed by some companies that could come up with any number of grounds for a change of measurement basis from historical cost to fair value or the other way around. It underscores the importance of ensuring company executives remain abreast of accounting developments long before they come into play and also the need to keep track of those standards in case somebody thinks it is a good idea to change them before they are finally implemented.

Disclaimer

The purpose of this database is to provide a full-text record of all articles that have appeared in the CDJ since February 1997. It is aimed to assist in the research and reference process. The database has a full-text index and will enable articles to be easily retrieved.It should be noted that information contained in this database is in pre-publication format only - IT IS NOT THE FINAL PRINTED VERSION OF THE CDJ - therefore there might be slight discrepancies between the contents of this database and the printed CDJ.